Beware of the Coming Activist Bubble

24/7Wall St.

You have heard of all sorts of bubbles in the financial world. There are instances like the housing bubble, a bond bubble, the dot-com bubble, the tech bubble, the private equity bubble, and on and on. 24/7 Wall St. wants to introduce the term "activist bubble," where too many super-wealthy advisors get too unruly in trying to milk out gains from stocks by pressuring companies into unlocking more shareholder value. We might not be in an activist bubble yet, but the trend of activist investing is getting to the point that a prudent investor might have to wonder if we are entering a new phase called the "Activist Investor Bubble."

Just a few years ago, the common themes were out-of-control finances and out-of-control corporate leadership with no accountability to shareholders (nor to any moral hazards). The pendulum has now swung the other way, and perhaps it is starting to swing too far. Perhaps. Now anyone with access to millions of dollars or billions of dollars can aggressively go after a company for corporate governance issues. This can be over executive compensation, how a company should be capitalized, what forms of stock it should have, what terms it should have for a merger, whether it should split the roles of CEO and chairman, anti-takeover provisions, retirement compensation and on and on.

If you begged us to guess whether activism will grow or contract, we would think that activism will continue. Does that mean that there is not a risk nor that this is a bubble that will not burst and end badly for the public? Those are complicated issues and it may be quite some time before we know the answer. What is so interesting here is that the activist world very recently has targeted what may be hundreds of billions dollars worth of companies.

There are many instances where we cannot help but wonder if an activist bubble is helping to bolster many stocks. For starters, activists can often drive up a stock and create wonderful value. Sometimes they can get out of control, and sometimes they can go out and create absolute value destruction. The saying "there is no free lunch" is one that cannot be ignored, even by activists.

One big activist dilemma is General Electric Co. (NYSE: GE). GE is so large that forcing change is hard to do, but calls have been made over and over to break up the conglomerate's empire. The problem is that weak units during one part of the business cycle act as cover for the other units when the business cycle changes. An activist might have said that GE needed to not cut its dividend during the recession, but this freed up enough capital that it probably saved quite literally tens of thousands of jobs at GE in the recession. Others have called for new leadership other than Jeff Immelt, while Immelt's greatest blunders may simply have been that he took over after Jack Welch, when GE was trading close to 30 times earnings, and Immelt's first day as CEO was quite literally a few days before the September 11, 2001 terrorist attacks.

A few powerful men with many financial backers behind them have gone after some really big companies. Again, this train is moving what is nothing short of hundreds of billions of dollars worth of companies. What you have not seen is why this may be a bubble. There is a serious risk in driving shareholder value in the short-term. Anyone can go in and propose layoffs, a spin-off, a recapitalization, a change in management and the like. The problem is that this effort can gut a company or it can merely be a win during one part of the business cycle.

Many efforts can be taken to unlock shareholder value. Special dividends can be issued. Debt can be taken on to pay a dividend or to buy back shares. Companies can go out and seek strategic alternatives. Companies can make their boards easy to change or they can get rid of any barriers that might lead to takeovers. There are dozens of more things they can do. The question to ask is whether creating short-term value comes at the cost of adding too much long-term risk. These risks are potentially serious issues that investors chasing activists have to consider.

The highly public verbal boxing match between Carl Icahn and Pershing Square's Bill Ackman on CNBC may have been the formal start of the activist bubble. When you get a guy who is vocally attacking a stock to drive his short sale bet against the company into a personal fight where an activist who is calling out the sort seller in a very ugly and personal way on TV, you have to wonder. That is Carl Icahn versus Bill Ackman on Herbalife Ltd. (NYSE: HLF). Herbalife remains a battleground stock with bears attacking it at every corner and bulls marching behind it. Dan Loeb, via Third Point, was involved but now may be out of the fight. How this ends is anyone's guess now.

And what about the activist case against Apple Inc. (NASDAQ: AAPL)? The greatest growth story in America has run into serious growth issues, and it has barely made any concessions on redistributing its vast capital mountain that is more than $100 billion in cash. For an activist investor like David Einhorn's Greenlight Capital to go after Apple seemed way too soon and way too aggressive. Einhorn was not calling for Tim Cook to admit that he is no Steve Jobs nor to resign. Instead, he wanted to vote his half-billion dollar stake and get others to vote for Apple to create a preferred stock to redistribute its wealth in that manner. Yes, it is true that Apple's stock has lost its luster, but after the growth that it created, it would be easy to think that perhaps Einhorn was being too greedy. Some existing holders were even telling Einhorn to shut up.

Carl Icahn is perhaps the public face of activist investing. He has gone after Netflix Inc. (NASDAQ: NFLX) and was perhaps more lucky than he was good there. The filing alone drove shares up about 10% to more than $76 on the news that Icahn took a 9.98% stake and wanted to meet with management to drive shareholder value. But the Walt Disney Co. (NYSE: DIS) re-signed a content deal that was part of the problem, and Netflix seems to have gotten its mismanagement steps under Reid Hastings behind it. Now shares are up around $180.

Hess Corp. (NYSE: HES) recently has buckled to activist investor pressure from Elliott Management. Its move is from an integrated oil player into an exploration and production play. It has a new slate of directors, and it boosted its dividend and started a share buyback plan. The move seems to have worked as its shares are up 30% so far in 2013. How many other big oil companies can claim that? With its $23 billion market value, activist pressure has added some real value to the stock. Fitch views the move as mixed for its credit rating and that may be important considering that it is barely investment grade at BBB ratings.

Another incident in which things sort of flopped for Carl Icahn was when he publicly went after Clorox Corp. (NYSE: CLX) in mid-2011 to try to drum up a buyout. He offered to acquire Clorox and took a 9.4% stake, but it really looked like all he wanted to do was to see if he could trick one of the larger consumer products giants or conglomerates into making a better offer. Icahn's offer of $76.50 per share was too close to the market price to gain traction, but the stock is now only at $82 and the breakout above $80 did not come until the start of 2013. Clorox is a boring consumer products company, but it does give investors a 3% dividend yield.

Procter &amp; Gamble Co. (NYSE: PG) was another odd activist fight. Bill Ackman and Pershing Square went after the company because its share had floundered for some time. The stock has recovered some, but even at all-time highs it really has not risen handily. CEO Bob McDonald probably was close to being ousted, and even in our own poll we had 55% say "change management" as the most voted on measure. Our issue was that, if Carl Icahn could not move the needle at Clorox with a $9.5 billion market value, it seemed a stretch that one vocal investor would make a huge difference in a very large company worth a whopping $200 billion. Perhaps the only way to unlock that value is a breakup, but we will leave that to the company and to other activists with more time and money than common sense.

Another big flop for Carl Icahn was Lions Gate Entertainment Corp. (NYSE: LGF). Icahn used CNBC one day in 2011 to go after management in an argument that sounded off-base at the time. He may have made a little or lost a little on that, but by selling out at $7.00 in mid-2011 he missed a major ride. Shares rose to $8 by the end of 2011, but then came a serious bump from The Hunger Games. Lions Gate shares hit $16 by April. Today they are higher than $21. Again, not even the activist investors get a free lunch.

A recent attack on the Walt Disney Co. (NYSE: DIS) is another instance where shareholders ganged up to try to force change. A recent demand to split the chairman and CEO roles from Bob Iger from three state pension funds was rather well publicized, along with support from Glass Lewis and ISI. This was not traditional activism at all, but it appears that about 65% of the shareholders opposed the effort as Iger was renominated by a 98% vote. Shareholders should love Iger, as Disney's stock has more than doubled under his tenure to a new fresh all-time high. We have even gone as far as to say that Iger basically stole the Star Wars franchise, even at a sum of about $4 billion. This form of activist investing did not cause losses for the groups seeking to split the chairman and executive roles, but it sort of looked and felt silly when you consider what Disney's stock has done with big media deals under Iger.

The saga for the Dell Inc. (NASDAQ: DELL) buyout is becoming epic. Michael Dell has a $13.65 per share buyout offer with private firm Silver Lake and also with some preferred financing from Microsoft Corp. (NASDAQ: MSFT). Icahn is involved here, with a stake of what is said to be around 100 million shares. Southeastern Asset Management is voting against the Dell deal and it has more than 123 million shares of Dell. Other shareholders are very against the price being too low as well. What is amazing is that Dell is now worth $24 billion, and even with all that newly printed money by Ben Bernanke, it gets harder and harder to imagine that investors can or will pony up endless dollars to buy a PC-maker. Beware something that we consider a unique angle. We think that perhaps Michael Dell does not really want to take Dell private and it may just be the ploy of a billionaire to establish a serious price floor under the stock. Activists here could learn a very painful lesson.

Yahoo! Inc. (NASDAQ: YHOO) has seen an ongoing activist attack. It is probably of no real surprise that Carl Icahn got involved here as well. The good news is that the company finally ousted Jerry Yang. The bad news is that the old buyout from Microsoft Corp. (NASDAQ: MSFT) is ancient history and may represent a valuation ceiling in the future. Marissa Mayer has driven value here by narrowing the focus of Yahoo!, cutting out unprofitable or low-growth efforts, and she has even managed to be the first person to unlock the value of its Alibaba stake. Some activists have made real money if they got involved this time, but they lost their ass(ets) by trying to force Jerry Yang into action.

Genworth Financial Inc. (NYSE: GNW) is a shell of is former greatness. Highfields Capital Management, under Jonathon S. Jacobson, got involved here in June of 2012 with a larger stake and the desire to pursue dialogue with Genworth. The target was regarding the mortgage insurance operations, as well as and Genworth’s retirement and protection businesses. Genworth is still in the process of trying to get out of certain operations, and this remains a developing story.

SPX Corp. (NYSE: SPW) may seem small in comparison, with a market value of "only" about $3.8 billion. The stock has never fully recovered from the prerecession highs, and its stock has been somewhat range-bound over the past three years. The firm Relational Investors has an 8.8% stake and has called it undervalued, with an attractive business yet subpar shareholder returns and subpar profitability. The argument is that it has overspent on acquisitions. Relational wants to get the company to take certain measures and has warned that it will press for strategic alternatives to be sought. This one is ongoing and the outcome is pending.

Navistar International Corp. (NYSE: NAV) is another activist stock that has Icahn involved. The company's problems have grown and grown to the point that some have questioned the tracking company's long-term viability. After the company appointed Mark Rachesky and Icahn-appointees to the board and split the roles of chairman and CEO, shares skyrocketed to back above $30.00. This is far from over, and Navistar would have to rise to more than $43.00 before a new 52-week high is hit again. Even after the gains, this is still only a $2.5 billion company. Shares could double and they would still be under the $70 or so post-recession high from as recently as 2011.

ValueAct is another investment group that is active in activist investing. Most recently its support has been around the proposed sale of Gardner Denver Inc. (NYSE: GDI), but that is not a very large company and its market cap is $3.6 billion. ValueAct's stake is worth less than $200 million here, and it manages more than $8 billion. Motorola Solutions Inc. (NYSE: MSI) has a large stake owned by ValueAct (about $1.8 billion) and it has been written about as having a board member involved and more shareholder friendly governance efforts.

GAMCO Investors Inc. (NYSE: GBL) is run by Mario Gabelli, and his nickname is Doctor Love because he loves putting companies into marriages (mergers). His firm is well known for creating an analysis that is called a "private market value," and this is generally an amalgamation of best case financial models to derive upside that is often far higher than Wall St. brokerage analysts traditionally have. Gabelli's pressure for a higher price from the Dolan family for Cablevision Systems Corp. (NYSE: CVC) did not go exactly as many investors would have hoped, but Gabelli has been right so many times that this is just one bad instance in what has been a brilliant and successful career. Gabelli and GAMCO have recently been involved in shares of K-Swiss Inc. (NASDAQ: KSWS), Rochester Medical Corp. (NASDAQ: ROCM) and Ferro Corp. (NYSE: FOE).

AOL Inc. (NYSE: AOL) already may have been recovering on its own after a sharp sell-off, but an activist campaign was launched by Starboard Value in 2011, and that definitely helped AOL make moves to get rid of some money-losing efforts and to sell its patents. AOL shares have more than tripled off of the lows from 2011. AOL even paid out a large special dividend of $5.15 per share in late 2012.

Barnes &amp; Noble Inc. (NYSE: BKS) is currently benefiting from a proposition from chairman Leonard Riggio to possible break up the company by selling the book store chain and keeping the Nook efforts. Jana Partners's Barry Rosenstein scored a huge gain on this same company in the past after Microsoft Corp. (NASDAQ: MSFT) came into the Barnes &amp; Noble fray. That may have been a bit of luck as well, but making a big gain is making a big gain. Rosenstein even once went so far as to say that when he invested here he was getting the Nook business for free. Barnes &amp; Noble is currently worth almost $1 billion.

CommonWealth REIT (NYSE: CWH) recently has come under activist pressure from firms Corvex Management and Related Cos. This was to halt a stock sale. The companies had previously put out a preliminary bid of $27 per share to stop an equity offering. The two companies have threatened to have the REIT's board of directors removed. Shares are currently under $22, and the shareholder suit against the company appears to have withered on the vine since Commonwealth did close on its sale of $627.6 million for a new 34.5 million shares. Taking control was not easy here, and it appears to be a new flopped deal of activist investors.

Seen enough? It seems that activist investing is all over the place. Is it a bubble? Maybe, but the bull market allows for investors to gang up on underperforming companies. A falling stock market and a systematic destruction of wealth put most management teams in the situation that they are not as easily called out on an individual basis. Is this a bubble that will burst or end badly for shareholders? Probably not, but that all depends on how ferocious the attacks against management teams become.

The efforts described here are a small portion of the current and recently ended deals. That being said, activist investors are trying to drive the train for companies worth hundreds of billions of dollars. Procter &amp; Gamble Co. (NYSE: PG) has a market value of $210 billion. Walt Disney Co. (NYSE: DIS) is worth some $101 billion. Yahoo! Inc. (NASDAQ: YHOO) has a market value of $25 billion, and both Dell Inc. (NASDAQ: DELL) and Hess Corp. (NYSE: HES) are not that far behind at all. Those few companies add up to nearly $400 billion alone.

Upon embarking on this effort, it already seemed as though activist investors were trying to force change at too many companies. The term "too many" may just be in the eye of the beholder, because it is rather obvious that activist investors are going to keep their efforts up. Billionaires and multimillionaires usually keep doing what keeps working, so activist investing likely will not end until those activists and their investors get burned badly too many times. We cannot say that activist investing has peaked, yet we cannot help but to question if there is an activist bubble forming here.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information.
All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only.
Intraday data delayed at least 15 minutes or per exchange requirements.